The Future of Shale Gas I – Gas Market Structures and Geopolitical Scenarios

Shale gas has become a buzzword in recent debates about the future of global energy politics. Two studies aim to explore how the present and future development of unconventional gas resources might impact global energy politics, gas market structures, geopolitics and political (in)stability. Together they help to explore the potential future developments of the US and maybe global ‘shale revolution’. A first study deriving from an ongoing research project on the geopolitics of natural gas at the Center of Energy Studies at the Rice University’s Baker Institute reminds us that the image of a world dominated by vast amounts of natural gas is but one potential future. The second study, presented by the Hague Centre for Strategic Studies (HCSS), spells out in more detail what an ongoing ‘shale revolution’ might entail for the stability of major exporters of conventional oil and gas. I present these studies in this and a follow-up post. In this one, I start with the studies’ discussion of how gas market structures might transform and present four scenarios developed by the Baker Institute’s project.

The spectacular increase of shale gas production in the United States has fostered growing hopes in the world’s biggest economy regarding self-sufficiency in terms of natural gas (see figure below). As a result of this ‘shale revolution’, gas prices and the cost of energy have dropped significantly. Also for Europe, the increase in US unconventional gas production has substantial effects: Gas has become so cheap in the US that it has pushed substantial amounts of coal out of the domestic market to Europe, spurring debate about the future of Europe’s sustainable energy policies. Moreover, doubts about the competitiveness of Europe in the face of low US energy prices have emerged.

As both studies argue, shale gas has furthermore put pressure on the contractual relations by which gas is governed in the European market.

US shale gas production is making a big difference…

Gas Market Transformations

The emergence of US shale gas as a major parameter of gas markets leads to greater degrees of supply flexibility – Liquefied Natural Gas (LNG) plays a key role here (also see here). Pipelines are large, expensive infrastructures. Once in place, they stay where they are and determine trade flows over the long run. As soon as gas is loaded on a LNG tanker, however, it can basically go wherever its owners wants it to (considering, of course, transportation cost and LNG terminal infrastructure).

Increasing flexibility through LNG exports is a challenge to given contractual relations. Gas contracts have traditionally been concluded long-term and on a take-or-pay basis. The price of gas, furthermore, is normally pegged to the oil price. All these characteristics have come under pressure. Long-term contracts – good for security of supply but bad in terms of flexibility – lose their attractiveness for consumers with new, more flexible supplies coming in. Take-or-pay arrangements are first of all important for the producers, since they guarantee income no matter whether gas is ultimately sold or not – in some sense, therefore, they secure demand. For consumers these arrangements are a burden that might be avoided when new and more flexible supplies become easily available. Finally, the pegging of gas prices to the price of oil has become increasingly unpleasant with increasing oil price volatility throughout the last decade. Increasing availability of gas, flexibility through LNG, and a multiplication of suppliers work towards substituting these pegged prices for genuine gas spot-prices.

LNG tankers bring flexibility to the gas market.

In short, gas markets in Europe and potentially increasingly on a global scale may become more short-term, more flexible, and more independent in terms of pricing (less pegging this is). But the consequences of the ‘shale revolution’ do not stop at shifts in economic governance. They might, as the two studies highlighted above show, affect politics and geopolitics as well.

I first turn to the study emerging from the Baker Institute’s research project. In the context of this ongoing project, several workshops have discussed how natural gas can shape future international politics. The project presents various publications. Among these, you’ll also find one that specifies potential future developments of the world energy order. This publication is interesting because it does no rely on singular trends or projections but presents multiple scenarios. It stays clear of overly simplistic depictions of the future of shale gas and instead reminds us that surprise is always possible and even likely. The authors make clear that their ‘scenarios […] acknowledge the possibility of new, game-changing uncertainties, which have been a constant theme in global energy markets over the past several decades.’

They present four scenarios that vary along two main axes of uncertainty: the ‘level of success of bringing unconventional gas to the market’ and the ‘level of liberalization of global gas trade’. Their scenarios might be summarized as follows:

High success, high liberalization: In this scenario, shale gas production in the US continues to rise, leading to gas self-sufficiency and significant gas exports. Particularly the European gas market transforms into a buyer’s market experiencing downward pressure on prices and the abolishment of long-term selling arrangements and their pegging to the oil price. Competition is fostered by increasing shale gas production in various European states, Argentina and – by 2020 – increasingly China. While many states profit from these developments, the Middle East turns out being on the losing side in this scenario with energy prices and thus export revenues falling. After 2020, the overall gas market situation remains stable. Middle Eastern states, however, experience increasing financial problems that result in substantial cuts in domestic subsidies and public service wages. Several states in the Middle East experience public unrest and the perceived instability fosters substitution efforts away from Middle Eastern resources.

Low success, low liberalization: In this second scenario, US shale companies initially struggle with low gas prices in an oversupplied market. Moreover, resistance against shale gas production in the US grows on environmental grounds. Production levels subsequently decline. In the Middle East, confrontations between Iran and Qatar lead to a lowering of the latter’s gas output. Europe remains in a geostrategically problematic situation and China becomes increasingly geopolitically active in the Middle East and the South China Seas. Rising gas and oil prices push towards their substitution for coal. Particularly after 2020, protectionism spreads while oil and gas prices further increase. The increasing use of coal spurs fears about climate change and increasing discussion about geoengineering, which leads to further frictions in international politics.

Low success, high liberalization: Again, environmental concerns in the US hamper the success of shale gas production and oil and gas prices generally rise. Europe works to counter its own dependence by fostering internal gas market liberalization. It also strives to develop a Trans-Caspian Pipeline circumventing Russia. Russia, for its part, teams up with Iran and Qatar to form a new gas cartel and China aims to aggressively develop gas production in various countries. Particularly Western industrialized states, confronted with this situation, put growing focus on energy efficiency and renewable energies.

High success, low liberalization: This last scenario starts with a serious political crisis in Saudi Arabia that quickly transforms into a civil war. Oil exports drop and prices rise substantially. The US reacts by stopping gas exports and making efforts to substitute oil for gas in the transportation sector. Other states react by enacting their own unilateral policies – variously focused on nuclear power or domestic unconventional gas production.

The authors draw several lessons from their scenario work (which will be extended in the future): shale gas strongly interacts with both geopolitics and great powers; critical events such as natural disasters but also political change play important roles in the future development of gas and politics; particularly the collapse of important supply states could drastically change the future outlook; the move of gas into the transportation sector could become an important driver of future developments; renewable energy and climate policy are crucial for the future of natural gas production (although these feature only at the side of each scenario); and finally governance regimes that regulate the ownership of shale gas resources will make a difference.

A further conclusion might be drawn from these scenarios: No matter how the future of unconventional gas might look like, it will most likely not lead us into some kind of happy energy world. Each scenario implies some sort of geopolitical challenge.

High success, high liberalization might lead to instability in Middle Eastern states;

High success, low liberalization is itself driven by substantial geopolitical instability, this is the collapse of Saudi Arabia.

In the first and the last of these scenarios, the Middle East plays a particularly important role. Interestingly, however, the causality is different in each case. High liberalization and success might drive Middle Eastern instability, while Middle Eastern instability might hamper liberalization. Although these ascriptions of causality should not be overestimated since they are derived from a creative process rather than actual empirical research, they point to important interactions in the world energy order that should be further scrutinized.

And there is another point that I want to highlight: The scenarios presented above fit together well with a set of scenarios that I have presented in another publication on the world energy order in 2030 and Europe’s competitiveness (see here in German). The above scenarios demonstrate significant similarities to those elaborated on that context as follows (all titles translated):

‘high success, low liberalization’ equals ‘everyone in his own fashion’

Both sets of scenarios complement each other well. My scenarios focus on European domestic energy political options and highlight the role of climate policy and renewables in the world energy order. The above scenarios, of which I have only provided short summaries here, complement this focus with very interesting stories about the potential trajectories of future developments in terms of natural gas. There seems to be some kind of consensus about the space of potential energy futures here.

The second study, referred to at the beginning, presents a less open-ended approach. It instead applies modeling techniques to elaborate on potential instability of energy exporters in a ‘high success, high liberalization’ or ‘future in shale’ scenario. I will present the respective research design and findings in a subsequent post.